An
Incentive for Commercial Items Contracts

A Guest Article for Where in
Federal Contracting?

by Vernon
J. Edwards

June 19, 2000

On
April 5, 2000, Deputy Under Secretary of Defense for Acquisition
and Technology Dr. Jacques Gansler directed the military
departments and defense agencies to make 50 percent of their
service contracts performance-based by the year 2005. An
attachment to the memo said that performance-based contracting
facilitates use of the commercial items procedures in FAR Part
12 and that incentives should be used on fixed-price contracts.
In the Arnet
Open Forum, one participant asked whether
the use of incentives would be consistent with FAR
12.207, which
requires that all contracts awarded pursuant to FAR Part 12 be
firm-fixed-price or fixed-price with economic price adjustment.
Another participant expressed the opinion that agencies cannot
use incentives on commercial items contracts.

FAR 16.202-1 defines
a firm-fixed-price contract as one that “provides for a price
that is not subject to any adjustment on the basis of the contractor’s cost
experience in performing the contract.” The fixed-price incentive contracts
described in FAR 16.403 are not firm-fixed-price contracts, because the
incentive payoff depends on the contractor’s incurred cost and the contract
price thus varies based on the contractor’s cost experience. However, an
agency could use a firm-fixed-price contract that promises to pay a bonus for
excellent performance, but that does not link the bonus to the contractor’s
cost experience. Such a contract meets the definition of firm-fixed-price in
FAR 16.202-1 and thus could be used for commercial items contracts, whether
the bonus was to be a lump sum or a variable amount. Such a contract would
also satisfy FAR
16.402-1, which says, “No incentive contract may provide
for other incentives without also providing a cost incentive (or
constraint),” because the price would not be subject to any
adjustment based on the contractor’s cost experience.

Although
I think that the use of such bonus incentives would be permissible under FAR Part
12, I do not think that agencies should use them on contracts for
commercial items, because I do not think that such incentives are consistent
with commercial practice. Instead, agencies should use what I call award
purchase incentives. Under an award purchase incentive the government
promises to fulfill certain additional requirements for supplies or services
through the contractor in return for excellent performance.Under
an award purchase incentive, the government awards a commercial items contract
that includes line items and prices for both a purchase quantity (or term) and
an award purchase quantity. The contract includes a clause that reads
as follows:

Award
Purchase. The contracting officer will evaluate the
contractor’s performance in delivering the items identified in line item
0001 of this contract in accordance with the criteria in Attachment 1, Award
Purchase Evaluation Criteria. If at the completion of this contract the
contracting officer has determined that the contractor’s performance was
excellent overall, then Agency X shall purchase from the contractor its
requirements for the items identified in line item 0002 of this contract
during the period DD MMM YY through DD MMM YY, at the prices stipulated, up to
a maximum of _____ units, and the contractor shall deliver those items to
Agency X as purchased and as otherwise specified in this contract. Nothing in
this clause may be construed to limit the Government’s right to terminate
this contract in accordance with the Termination for the Government’s
Convenience and Termination for Cause articles in clause 52.212-4, Contract
Terms and Conditions—Commercial Items.

End of Clause

(The clause can be adapted for
use in service contracts.)

The line item for the award
purchase includes both an estimated quantity and a maximum quantity, like a
requirements contract, and limits the government's purchase obligation to its
actual requirements during a specified timeframe and up to the maximum
quantity. The prices for the award purchase are subject to economic
price adjustment based on established market prices (see FAR
16.203-1(a)), so that at the time of purchase they will reflect what is
considered to be fair and reasonable in the marketplace. In order to satisfy
the requirements of the Competition in Contract Act, the government must
evaluate the prices for the both the purchase quantity and the award purchase
quantity during source selection or the evaluation of sealed bids.

The government should not use
an option provision as authorization to buy the award purchase
quantity, but should cite the award purchase clause
prescribed above, instead. The clause makes the
incentive binding within the limits described therein, which
should make the incentive more attractive to a contractor than an
option. Using the award purchase clause instead of an
option would also avoid the need for the
contracting officer to comply with FAR Subpart 17.2
concerning the use and exercise of options. If necessary,
the contract can include a clause similar to the ordering clause
at FAR
52.216-18, so that the
government can specify delivery of the award purchase quantity
as needed.

The
award
purchase contract must include a description of the criteria that the
contracting officer will use to evaluate the contractor’s performance, which
must be sufficiently clear and detailed to enable the contractor to know what
it has to do to earn the award purchase incentive payoff. The criteria should
reflect typically commercial considerations such as product quality, delivery,
customer service, etc. Agencies should not use elaborate award fee-type plans
or procedures, but should use informal and streamlined processes of
communication, evaluation, and documentation.

One Open
Forum participant suggested that IDIQ contracts accomplish the same ends
as the award purchase incentive, because the contractor knows that the
government will not issue more orders if it is not happy with the
contractor’s performance. However, the incentive in IDIQ contracts is not
explicit, there is no firm commitment to buy more than the minimum quantity,
and IDIQ contracts require agencies to order a minimum quantity and make
multiple awards. Award purchase is an explicit
incentive; there is a commitment to buy that is contingent upon only
performance, requirements, and funding; and it is based on a
requirements-type bargain, which means that there is no need to
order a minimum quantity or to make multiple awards.

Commercial firms
will like the award purchase incentive because it is the kind of
simple incentive that they like best--loyalty from a satisfied
customer. Government agencies will like it because it
offers them the prospect of reduced administrative costs in the
making of additional purchases. All that agencies have to
do to make award purchase work is to keep it simple and use
commercial performance evaluation criteria.

Vernon J. Edwards researches,
writes, lectures, and consults about Federal acquisition.
From 1974 through 1986, he was a Federal acquisition official and
worked for the U.S. Department of the Air Force, the U.S. Small
Business Administration, and the U.S. Department of Energy.
From 1986 until 1998, he was a member of the faculties of The
George Washington University's government contracts programs in
the School of Business and Public Management and the Law School.